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Markets Vanish - 'In a Flash'

By: Fred Sheehan | Saturday, January 5, 2013

The same title cheered in the new years of 2011 and 2012 ("Markets
Vanish - "In a Flash"," January 4, 2011 and January 8, 2012). These
warnings described how quickly, and with no foresight by participants,
markets evaporated in 1914. In 2013, markets have never been more susceptible
to such a bolt of recognition. This is a consequence of such imperturbable
faith in the prices set by besotted bureaucrats. What follows is a quick
look at the nasty, brutish, and short results from government manipulations
after such policy failures.

There are few failures that compete with World War I. Having failed, the same
bumblers garnered fame by subjecting their own populations to conquest. Whether
it was the patriotic call to the trenches or confiscation of securities, there
is no question those who had failed worst made out best.

The British and the French governments were short of money to pay for supplies
by 1915. Note: this was still a world in which non-redeemable, government,
money-printing operations would not pass muster. If a hard-up, food- and munitions-famished
government attempted to print pounds or francs for goods, the boat from London
to New York would have made a round-trip after the counterfeit fodder had
been sequestered and burned at the Customs House on Bowling Green. The customs
officials would no doubt have been acting in good faith, an attempt to suppress
the embarrassment due the British or French governments in the belief that
some lunatic, war criminal had attempted to pass bad notes.

Instead, force majeure was employed. The following description by Harold
Nicholson goes beyond the specific point addressed here (underlined) since
the nearly insurmountable problem of those governments is unfamiliar in an
age of quantitative easing. Yet we are approaching the point (yep, any day
now baby, just you wait) when worthless Bernankes, Draghis, and Abes will
call for just such a calculus: "[W]hereas American exports to Great Britain
alone had in 1914 been $594,271,863, they increased in 1917 to $2,046,812,678.
This enormous expansion in the American trade export trade was due, of course,
to the European demand for more war material and food. Such purchases could
no longer be paid for in goods and services; only a small proportion could
be liquidated in gold; the purchases for 1915 alone were some $700,000,000
in excess of gold capacity; the balance had to be financed by credit. How
could such vast credits be obtained? Three separate systems were adopted.
The first was the export of gold; a billion dollars of gold were transferred
to the United States between 1914 and 1917. The second method was to commandeer
the American securities held by British and French nationals. This method
was first put into operation in January 1916, and in the end provided the
British government with the collateral of $2,425,000,000 and the French government
with the collateral of $51,000,000. The third method was just confidence." J.P.
Morgan acted as agent to the British and French governments.

To imagine governments would take such action demanded the mind of a Houdini
in 1914, even after markets had vanished in late-July. In the United States,
a country without an income tax in 1912, and a continent away from the fighting,
a 77% surtax on incomes was imposed after Americans embarked on its holy mission
to save European from itself. President Wilson told the leaders of the Federal
Council on Churches: "[Y]ou have got to save society in this world, not
in the next.... We have got to save society, so far as it is saved, by the
instrumentality of Christianity in this world." Wilson went on to compare
Christianity to the highest form of patriotism since they were both "the devotion
of the spirit to something greater and nobler than itself."

This was in December 1915. In 1916, Woodrow Wilson was reelected to a second
term as president with an appealing campaign slogan: "We didn't go to war." During
the presidential campaign, he wrote to his Secretary of the Navy: "I can't
keep the country out of the war." Nor, did he.

Having abused trust with the American people under the banner of a holy crusade,
the Wilson administration took measures inconceivable before 1914. This is
the lesson to be contemplated in 2013. We have two Holy Crusaders, one at
the Fed and one in the White House, both of whom (this is where it gets very
dangerous) view humanity in the abstract and who preach in the dreadful certainty
of the former Princeton College president (that would be Wilson).

After the U.S. declared war on European Sin (May 6, 1917), Wilson refined
his impersonation of American Gothic: "Woe be the man that seeks
to stand in our way in this day of high resolution when every principle we
hold dearest is to be vindicated and made secure." A Rip Van Winkle who had
been asleep since 1914 may have wondered if the "we" included a mouse in the
parson's pocket. George Santayana expressed doubts about such blending of
the material with the spiritual. Wilson and his fellow travelers were "fanatics,
who redoubled their efforts after losing all sense of aim." Santayana had
left his teaching position at Harvard in 1912, sailed to Europe, never to
return, but bequeathed a compelling indictment of American letters, especially
the poisonous, pious, and inert influence of Harvard upon American consciousness,
as true today as a century ago, and just as stubbornly ignored.

One sample of World War I financial mischief was the Liberty Bond. The first
of these offerings (in 1917) was a $2 billion issue, over ten times the size
of any previous effort. Given the scale, was a 3-1/2% coupon inadequate compensation?
Not by any means. Americans would buy them whether they wanted to or not,
(and who would?) Charles G. Dawes, chairman of the Liberty Loan Drive, declared: "Anybody
who declines to subscribe for that reason, knock him down."

This captures the spirit of U.S. economic policy ever since. In the Holy Quest
for GDP Growth, post-millennial economic policy has unerringly chosen to "knock
him down." The Greenspan Fed sustained an overextended economy with the Internet
bubble. Those who played it to the end got knocked down. Greenspan fanned
the housing bubble, handed the baton to Bernanke, who battered credulous mortgage-buying
Americans back to the stone age.

The 3-1/2% Dawes bond yields look gargantuan given today's investment alternatives.
This is not so much a question of yield as it is of quality. First and foremost,
money is not what it was. Most of what is considered money today is a claim
on a non-existent asset. This is a far deeper problem than when the British
and French governments ran out of real money during World War I. (They both
abandoned the gold standard, with consequences beyond today's discussion.)
Given how easily governments bullied and confiscated private citizens' property
a century ago - a far more civilized period than today - and the flagrant
lawlessness of Financial Repression today, the commandeering securities can
be accomplished in an instant of double-talk.

Sheehan serves as an advisor to investment firms and endowments. He is the
former Director of Asset Allocation Services at John Hancock Financial Services
where he set investment policy and asset allocation for institutional pension
plans. For more than a decade, Sheehan wrote the monthly "Market Outlook" and
quarterly "Market Review" for John Hancock clients.

Sheehan earned an MBA from Columbia Business School and a BS from the U.S.
Naval Academy. He is a Chartered Financial Analyst.